Predatory payday loans and why you should avoid them

Do a Google search for “payday loans” and you’ll hear a late 90s TV commercial in your head...“Get cash as soon as today!” or “5 Minute Approval. No FAX. Bad Credit OK.” Fast-forward 20 years and a no-questions-asked approach to accessing your money in advance is still the key message from payday lenders. Unfortunately, this marketing of accessibility is what draws unsuspecting consumers into a payday lender’s web of cyclical debt, particularly when consumers are down on their luck. With that preamble we say, “please avoid payday lenders at all costs.”

Debt lending, and the interest it charges, goes back nearly 4000 years, with early instances appearing in the Code of Hammurabi (for those of you who are not up to date on your ancient Mesopotamia, fair. The Code of Hammurabi was Babylonian law and one of the oldest texts on earth. Debt is a long game, clearly). Back then, the maximum interest rate a moneylender could charge, specifically for loans of grain, was 33% per annum. To a modern consumer 33% interest sounds like daylight robbery, but in the next few minutes you’ll realize that Hammurabi was onto something by capping interest at that rate (Note: we do not endorse an “eye for an eye”).

Before we dive in, let’s be clear: debt can sometimes be an incredibly powerful tool for building wealth. As we discussed in our article about surviving a recession, if you have a mortgage, this is considered a good debt on an appreciable asset, whereas, credit card debt is bad debt that should be dealt with immediately. Payday loans, however, are on another scale. The bad kind of scale.

If you are someone who is or has been caught in the web of payday loan debt, you are not alone. People have been paying back debt since 1754 BC! Even when it feels impossible, there are actions you can take to pay down your debts. We’ll outline a few of those actions later in this article.

What exactly are payday loans?

Let’s cut to the chase: payday loans are an egregiously expensive way to borrow money. They are short-term loans, typically of a few hundred dollars (up to $1500), that are repaid in full at your next paycheque either by direct withdrawal from your debit account, or a post-dated cheque. The rules and regulations vary across provinces, but the mandate is the same: suck clients into a cycle of debt, whereby they borrow more money to pay off the previous debt owed, compounding into a ridiculously high interest rate over time.

That’s exactly what happened to Jess Brown, a Torontonian who works at a tech startup and found herself mixed up in the world of payday lending when her pet unexpectedly took a costly trip to the vet. “My partner and I had a really high vet bill, and since I was in school, only one of us was working full-time,” she shared. “We needed something to close the gap so we could pay our rent, and a payday loan was the easiest way to do it.” Before she knew it, it was a couple of months before she could catch up on the payments. “We kept taking out a new loan to close the gap in our expenses.” That was a few years ago. “With disparity between income levels increasing,” Jess says, “I can’t imagine how hard it is today.”

"Debt lending, and the interest it charges, goes back nearly 4000 years, with early instances appearing in the Code of Hammurabi."

Is it fair that payday loans have a predatory reputation?

The short answer is yes, in fact, it’s even worse than you think.

The unfortunate reality is that Canadians who resort to a payday loan are doing so in an act of desperation to cover unexpected, necessary costs. They’re typically from low-income households and likely have a bad credit rating, essentially barring them from the less predatory alternatives.

Ruth Remudaro, who works at TouchBistro, was caught in a payday loan cycle in her first two years of University (2016-2018) for this very reason. “I had bad credit card debt and was denied an additional card by RBC. That’s how I found myself at a Money Mart,” she explains. She was working two part-time jobs and supporting herself entirely. When she couldn’t make rent or buy groceries, she felt her only option was a payday loan. And another. And then another. For two years she was caught in a cycle of debt, taking another loan to pay the previous one down. Ruth was finally able to end the cycle by finding an apartment with cheaper rent, and a job with higher pay. She also claims that opening up to her friends about her situation, without receiving judgment, was essential to breaking her debt cycle with payday lenders. But when it’s over, is it really over? On whether or not she would ever recommend payday loans Ruth shared,

“I would highly recommend against it because it won’t only affect your financial situation, but could also make your mental health wonky. I paid off that loan from 2016 and I still don’t feel like it’s over. Even though I have all the documentation to prove it. It still feels like a scam. The whole process feels like a scam.”

If you’re still asking yourself if “is predatory really a fair word to use?” let’s paint a picture. In 2016 the Financial Consumer Agency of Canada released a report on payday loans that revealed the average cost of a $300 loan (for two weeks) is $63! That means 21% of the money you borrow is automatically eaten up by fees.

Costs accrued on a $300 14-day loan:

• Line of Credit - $5.81

• Overdraft Protection on a Bank Account - $7.19

• Cash Advance on a Credit Card - $7.42

• Payday Loan - $63

From this report, the government points out that a payday loan costs $17 per $100 borrowed, which works out to an annual interest rate of 442% (cue Hammurabi rolling over in his tomb). In other articles, we’ve been quick to highlight that the most important debt to eliminate is credit card debt, which carries an annual interest rate of 23%. We were wrong. Payday loan debt is astronomically worse and that ain’t a hyperbole.

There’s an old Yiddish proverb that perfectly illustrates the unfortunate resilience of payday loans: “Interests on debt grow without rain.” Come rain or come shine, the interest on these types of loans grow (and grow and grow).

"From this report, the government points out that a payday loan costs $17 per $100 borrowed, which works out to an annual interest rate of 442%."

What can you do to avoid payday loans?

In the short term, please try anything else. It is completely understandable that in a pinch, hasty reactions to find the path of least resistance are a natural response. But there are almost always other options. We’ve outlined a few of them below.

Ask for a grace period

Contact the people, or businesses you owe money to and ask for a little more time to pay your bills. Be open and honest about your situation, and be clear on when you get paid next. If you can, providing a post-dated cheque will increase your odds of making this scenario successful.

Explore the resources already around you

Talk to your employer about an advance on your next paycheque or consider cashing in a few of your vacation days. Credit score permitting, consider opening a line of credit or personal loan with your financial institution. Not the best option, but even consider a cash advance on your credit card. As we outlined earlier, their annual interest rates (which are still very high), are peanuts compared to a payday loan.

Lastly, and potentially the toughest, ask a friend or family member who understands your situation if they are in a position to help you out.

Reflecting back on her time stuck in payday debt, Ruth wishes she had reached out to her support system sooner:

“Not all debt is bad, but if anyone wanted to get a payday loan, I would highly advise them to reach out to the people in their lives first. I’ve since taken loans from friends, and it can be difficult, but having that personal support and being vulnerable about your finances will build stronger relationships. Everyone should feel comfortable to talk openly about their finances, and we don’t do this nearly enough.”

But I’m already caught in a debt cycle, what can I do?

If you’ve exhausted the options just mentioned, seek advice from reputable professionals such as an accredited credit counsellor, financial advisor, licensed insolvency trustee or an insolvency lawyer. A simple conversation with one of these trusted parties should help you move miles ahead of where you are today. They can assist you, specifically, with what you should be thinking about, options to weigh, and a solution-driven path. Remember that these conversations are non-judgmental, totally confidential, and in many cases, free! With 20/20 hindsight vision, Ruth expressed, “I wish as a 19 year old someone told me that I’m allowed to ask for help and support.”

If you happen to be a KOHO Premium user, remember that you have free access to our in-house financial coach whose goal it is to elevate our users on their financial journey, whatever path that may be!

"I wish as a 19 year old someone told me that I’m allowed to ask for help and support."

How can I get ahead of this for the long term?

There’s never a bad time to create a budget, and start building up your slush fund. Even a few dollars consistently set aside in an easy to access savings account will help take some of the pressure off in the event of an unexpected expense or emergency.

If you’re currently carrying credit card debt, focus on trying to pay it down as much as possible. That way, if you find yourself in a pinch, you can take a cash advance on your credit card and not find yourself in a Money Mart. The hard reality is that this too is a cycle of debt, but at a much lower cost than resorting to predatory payday loans.

What’s this got to do with KOHO?

We like to view these articles as “the crash course you never got in school.” Our aim is to educate and equip our community with the knowledge and tools they need to develop financial literacy, and most importantly, autonomy.

In addition, we’ve launched Early Payroll for our users receiving a direct deposit to their KOHO prepaid Visa account. This means accessing $100 of your money prior to your next paycheque with no interest and no strings attached. When your paycheque is deposited into your account, we’ll remove the loaned $100 direct from your account. We’ve launched two types: Early Payroll Free and Early Payroll Instant. Free gives you access to $100 up to 3 days before your next paycheque and the Early Payroll Instant gives you access anytime and financial coaching for 15 days. We hope this can help Canadians make payments on time, avoid NSF fees, credit debt, or having to resort to payday loans.

Debt lending has been common throughout history from Cicero in the Roman Republic, hawala in the Middle East, up to Henry VIII in the 16th century. If you’re caught in a debt cycle, remember that you are not the first and certainly won’t be the last person in this situation. Explore as many routes of assistance as you can (there are people out there who want to help!) and be kind to yourself, debt is a normal part of life. Your future self, and mental health, will thank you for it in the long run.